Denbury Resources Inc. said that it cut 15% of its workforce on Aug. 10, consisting primarily at jobs at the oil and gas company's headquarters in Plano, Texas. Speaking late Tuesday at the EnerCom Oil & Gas Conference, Chief Executive Christian...

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Operating solely in the U.S. Gulf Coast region, Denbury Resources is the leading oil and natural gas producer in Mississippi. Headquartered outside of Dallas Texas, Denbury Resources strives to increase the value of their acquired properties by implementing unconventional extraction processes, mainly tertiary recovery. Tertiary recovery, sometimes called enhanced oil recovery, aims to increase the quantity of oil extracted and thus increase production.

As owners of the largest carbon dioxide reserve east of the Mississippi,[1] Denbury’s emphasis is on the most common form of tertiary recovery, gas injection. Gas injection has tremendous potential. The process enables producers to extract anywhere from 30-60% more of the original reservoir due to improved viscosity and reservoir expansion. Furthermore, nearly half of the CO2 can then be extracted from the oil and re-injected, decreasing operating costs and minimizing CO2 depletion.

Although the possible benefits of carbon dioxide injection are significant in the long run, the process has recently hurt DNR by increasing operating expenses by 33% while only accounting for only 3% of domestic oil production.[2] Despite these figures, management has remained focused on their tertiary operations because they believe their competitive position is improved by their CO2 holdings (as they own the only known significant source east of the Mississippi) and they have yet to encounter any competition in their region.[3]

One of the main challenges confronting oil and gas companies across the board is the depletion of the commodities that drive their business. As a result, producers such as DNR must actively search for new reserves or maximize the extractions from their current holdings. Generally speaking, DNR's focus has been maximizing returns on their current portfolio. Therefore, the company specific risk is somewhat different than many of its competitors because although their acquisition strategy is comparatively conservative, they face the risk of inefficiently leveraging their competencies in the CO 2 arena.

As seen below, Denbury Rescources has shown steady growth in revenue over the past several years which, of course, can be attributed to the soaring price of oil. However, despite this growth, the growth in operating profit has lagged behind, mainly due to increased expenses in their tertiary operations such as the development of an underground pipeline infrastructure which is used to transport the carbon dioxide to DNR's drilling locations.

Below is a regional breakdown of the company's holdings. The Mississippi section, which constitutes 36% of total proved reserves, is primarily CO2 floods in which they use for tertiary recovery.

Trends & Drivers

Focus on CO 2 Operations

Over the past several years, management has been learning and heavily investing in both current and potential CO 2 plays. Today only about 3% of domestic oil production is derived from CO 2. Management views this statistic as an opportunity to achieve significant growth in an untapped market. Furthermore, their confidence is reflected in their 2007 capital budget, as they have allocated 60% of it towards CO 2 operations.[4] In addition to DNR's huge reservoir of natural CO 2 mentioned earlier, in 2007 the company contracted to purchase two man-made CO 2 sources. Although the purchase of these man-made CO 2 sources is likely to be more costly, it is expected to facilitate the CO 2 transportation and help boost production three to four Tcf over the life of the company's existing contracts.[5] In addition, they have been expanding their pipeline infrastructure to improve CO 2 delivery.

DNR, just like other players in the oil and gas industry, is highly dependent on favorable market prices for oil & gas, which tend to fluctuate significantly over time.[6] With the recent rise in the price of oil and gas, the margins of most exploration and production companies have been improving. However, as mentioned earlier, DNR's operating expenses have been increasing on both an absolute and per barrel basis [7] and they have not enjoyed some of the successes as their competitors on a relative basis. Also, it should be noted, that due to the extremely volatile prices for oil and natural gas, the company usually hedges the prices at which it can sell oil & gas. By use of derivatives, the company attempts to lock in a price or a range of prices, which limits downside but also presents an opportunity cost if oil prices rise significantly over the lives of contracts.[8]

Potential carbon credits may lead to a significant cost advantage

Rising oil prices have led both consumers and companies to seek out alternative sources of energy and to invest in renewable energy such as nuclear, solar, wind, biofuels, and ethanol technologies. As global consumer demand shifts toward renewable energy sources and incentives to develop long-term solutions to the world's dependence on oil and gas become stronger due to recent environmental concerns over climate change, consumer consciousness and the entrepreneurial profit motive may adversely affect the oil and gas industry. Although this shift will most likely negatively impact the industry as a whole, DNR's management is hopeful that they will receive carbon credits in the future for applying their CO 2 technologies.[9]

DNR owns acreage on onshore North American sites, including the resource rich Barnett Shale

Texas' Barnett Shale formation has proven to be one of the industry's favorite sources for consistent and reliable returns. In the first quarter of 2008, DNR improved their quarter over quarter production in the prolific area by 84% [10] In addition to DNR's operations in Texas, they also own significant reserves in Mississippi and Alabama. See the pie chart above for a geographic breakdown of proved reserves. Note, the Louisiana properties were fully divested by February 2008 [11]

Competition

The oil and gas industry is extremely competitive. As a result, it is crucial for some firms to remain competitive through a combination of technological innovation and savvy management. Denbury Resources, as one of the industry's pioneers for unconventional drilling techniques, aims to differentiate themselves through advanced tertiary operations. In the long run, management is hopeful that they can profitably stand by their strategy, avoiding risker ventures such as Deepwater Oil Exploration and new acquisitions.

Below is a table comparing several metrics from some of the main players in the independent oil & gas industry.[12] Note that DNR has the least amount of gross acreage, further demonstrating their reliance on managerial and technological wherewithal.

↑ MMcfe/day, or millions of natural gas cubic feet equivalent, is a measure of the level of production per day that converts oil into the energy-yielding natural gas equivalent using a ratio of 6 to 1 (natural gas to oil)